5 Stocks to Consider Ahead of Earnings - 10112 views

MINNEAPOLIS (Stockpickr) -- The stock market is enjoying a nice rally as the second quarter comes to an end. A deal to save Greece from default, at least for now, has helped to ease the fear that had been in place for several weeks. With corporate earnings expected to be strong, investors are placing bets early in hopes that profits will outweigh nervous speculation.

I get that investors are worried, but stocks are simply too attractive to ignore. Weakness in the latter half of the second quarter was altogether expected. Sure, there were some scary headlines, including a soft patch in the economy and much too weak employment figures, but for the most part, this market was due for a pause.

Stocks do not go up in a straight line. There are ebbs and flows along the way. We’ve just experienced a short period of flow to the downside based mainly on speculation of economic weakness. The facts do not support such an argument.

Earnings on the S&P 500 have been strong and show no signs of slowing. The average sell-side analyst estimate for the large company index is $99.76 per share. With the S&P 500 just over 1,300 at the end of June, the index trades for just 13 times current-year estimates. Take a more pessimistic view and assume the index generates $92 in earnings, and it is still cheap at 14.3 times earnings.

Analysts and strategists both expect S&P 500 earnings to grow by 10% or more in 2012, with the most optimistic view expecting solid 13.4% earnings growth. There is no excess in these prices by any stretch. With interest rates holding at historically low levels and no sign of real inflation dollars can be expected to flow to the stock market eventually driving up prices.

Anything can happen along the way, but things are looking good for investors at the moment. I was cautious from the beginning of May to mid-June. Since that time, I have been bullish, expecting an earnings-fueled rally. It looks like that rally has begun.

When FedEx (FDX) reported earnings last month, the market was still in a funk. As a result the news barely registered with investors. Instead the focus was on nonsensical things that may or may not materialize, such as a default in Greece or collapse of the American economy. Thinking macro and ignoring the micro results at Fed-Ex was a mistake.

There is no such thing as crystal ball that can predict the future in the economy or the market. The best we can hope for are clues as to short-term and long-term operating performance. Since operating performance is tied to valuations, reading the tea leaves from earnings can help investors can an edge in the market.

In the case of FedEx, those tea leaves are even more significant due to the bellwether nature of the company for the rest of the economy. In addition, the company is dependent on jet fuel, and the impact of rising crude prices has been a big worry for many market participants.

The good news is that FedEx acknowledged the challenges and still delivered a report that beat expectations. In addition, guidance was higher than expected and showed no sign of ill effect of a slower growing economy and higher crude prices. Bulls could not ask for more.

FedEx shares are up about 7% since reporting results on June 22. More gains should follow. Shares trade for 14 times earnings, with profits expected to grow at that rate or more.

The height of insanity of the bearish argument in the market can be found in the price action of technology stalwart Apple (AAPL). When shares bottomed on June 20, investors could buy Apple stock for $310.50. That number brought the stock below its 200-day moving average, if only briefly.

Talk about a buying opportunity. Shares have since spiked 12% as investors realize the error in current market pricing. What has this company done to deserve such widespread selling? Nothing but deliver huge profit growth with the potential for more.

For the last two reporting periods, Apple has whipped estimates by a wide margin. That is a remarkable result for a company with few secrets and millions of market participants watching and analyzing the company on a regular basis. My guess is that another beat of average analyst estimates is forthcoming.

When Apple last delivered the goods, shares jumped more than 5% and peaked at $355 per share. History is likely to repeat itself. Wall Street expects the company to make a profit of $5.68 per share when it reports results for the second quarter ended June 30. A meet or beat of the number will have Apple on track to make the expected yearly profit of $24.80 per share for the year ending Sept. 30.

With the company expected to grow profits by 16% in the following year and shares trading for just 13.5 times earnings, how can you not buy this stock? Owning Apple today is free money in my opinion.

The days of across-the-board excessive valuations are over, as evidenced by the low multiple of earnings that the S&P 500 trades for today. That said, there are some notable nosebleed valuations, including the pricing of Salesforce.com (CRM). Shares currently trade for 114 times estimates of $1.31 per share for the current year ending Jan. 31, 2012.

I can appreciate that this company is growing at an expected clip of more than 40% from this year to the next, but let’s not get too crazy here. I love a great momentum story and included Salesforce.com on a list of stocks to own for 2011 published last December. Today, I’m not so sure I would own the stock.

A quick perusal of Salesforce.com’s performance against Wall Street estimates shows four straight quarters of meeting or beating expectations. Those numbers are nice, but not impressive enough to merit the current valuation. Compared with Apple, a far more interesting company with a proven history of consistent high profit growth, Salesforce.com is a riskier play.

My original thought was to own Salesforce.com as a blow-off rally trade. Momentum stocks tend to boom shortly before a market reversal. With shares up only 13%, we are far short of a blow-off. At the same time, the economy and market shows few signs of a turn. Stocks may go higher from here, but Salesforce.com could lag as investors buy value instead of momentum at this next stage of trading.

I'm an unabashed Sirius (SIRI) enthusiast, but it's time to admit that the jig is up. Many years ago, I was a big believer in the stock and its business model. It was easy to value the company significantly more than current market prices using conservative assumptions about subscriber growth, advertising revenue potential and pricing power.

Even with near disaster in 2008, I recommend the stock when shares were trading for 50 cents per share. That was a great call with the stock, which now trades at over $2 per share. My confidence in making that recommendation was due to the monopolistic features the company enjoyed thanks to the merger between Sirius and XM.

Unfortunately, the long wait for government approval of those monopolistic tendencies and the near-brush with bankruptcy have allowed other forms of competition to solidify their positions in the market. With more competition from the likes of smartphones and companies such as Pandora (P), it is hard to justify Sirius’ $8 billion market capitalization.

The average Wall Street estimate for earnings in the current year is 5 cents per share. That number jumps 40% to 7 cents per share in the next fiscal year. That is a big percentage jump to be sure, but a bit of an illusion given the pennies of profit being generated. Shares trade for 40 times the current year estimate.

It will take a much stronger economy for Sirius to flex its monopolistic pricing power. I’d be cautious on this stock at current levels.

If you like aggressive risk in your search for huge returns in particular stocks, stick to the small-cap segment of the market. These smaller stocks have less coverage and press than the larger names in the market but can deliver big gains because of big profit growth. One such stock is TravelCenters of America (TA).

This just under-$100 million market cap company owns and operates a number of filling stations along the federal highway system in the U.S. Shares of TravelCenters exploded higher earlier this year from under $4 per share to over $12 thanks to refinancing lease payments on facilities effectively restructuring the company’s balance. What had been questions about profitability and survivability are now replaced with more certainty about future profits.

The heavily shorted stock benefited from a short squeeze, but shares subsequently sold off after the impressive gains. With the emotion and noise of the deal removed from the stock what is left is execution. The one Wall Street analyst covering the stock pegs earnings this year at thirty one cents per share and eighty cents per share next year.

You can buy the stock today for just 6 times next year’s number. There is risk in this stock for certain, but if the company performs as one analyst expects, returns could be explosive. This stock could easily double in value between now and the end of this year.

At the time of publication, author had no positions in stocks mentioned.

Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.